National debt relief is worth it

ECB Debt Relief: No First Strike Strategy; at most an emergency solution

Since the outbreak of the Covid-19 crisis, a debate has arisen over whether we should write off the national debt with the central banks. Despite its technical feasibility, debt relief is not the first thing that is worth fighting for.

This is a German translation by Marc Beckmann of an article originally published in English 🇬🇧 on December 17th 2020. (A 🇫🇷French and Italian translations of this article are also available.)

Since the beginning of the pandemic, a number of economic taboos have been broken - starting with the suspension of fiscal rules and the massive expansion of the ECB's balance sheet. Even more creativity will be needed to overcome the economic damage caused by the Covid-19 recession and its aftermath.

At the beginning of February, over a hundred economists demanded that the European Central Bank should cancel the 2.8 trillion euros in national debt that it holds as a result of its massive bond purchase programs. The economists argued that this would avoid austerity measures and would enable euro area countries to invest an equivalent amount of money in long-term, sustainable investments.

At first glance, the suggestion makes sense. The central banks in the euro zone currently hold around € 2,800 billion in government debt, which is around 30% of the national debt in the euro zone. In practice, the national central banks hold their country's debt, while only a small part (10 to 12%) is held on the ECB's balance sheet itself.

Proportion of public debt owned by central banks

Since central banks are typically owned by their states, they redistribute a large portion of the profits from this national debt to their governments through their usual dividend distributions. So when a country pays back to the ECB, a good portion of the money comes back as a central bank dividend.

In other words, we owe 30% of our national debt to ourselves. So we might as well write off this debt. In this way, governments would see a nominal decline in their public debt and would therefore have more budgetary leeway to increase public spending rather than get caught in a deadly spiral of austerity.

However, not everyone likes the idea, as several high-ranking ECB representatives, including Christine Lagarde, Fabio Panetta and the French central bank president François Villeroy de Galhau, have clearly spoken out against the proposal.

Positive Money Europe has followed this debate closely. In this article we want to explain why the proposal, while technically feasible, has many legal and political complications. After a thorough strategy analysis, we decided to shift our current focus to other proposals.

Debt relief is technically feasible

First of all, however, we would like to say loud and clear that we fully support the technical side of the proposal.

It is crucial to understand that the proposed debt relief specifically targets the 25% of public debt owned by central banks, rather than the debt held by private investors and savers. So it is a very different type of debt relief from the one granted to Greece or Argentina a few years ago.

In other words, the pensioners would not suffer from this proposal. Only the central bank's balance sheet would suffer. The question that now arises is what this means for the central bank.

Critics often argue that if central banks agreed to cancel sovereign debt, they would suffer such a loss that they would quickly go bankrupt and need a taxpayer's money bailout.

However, this objection is not really convincing. As Christine Lagarde recently pointed out, the ECB “cannot go bankrupt or run out of money”. There is an obvious reason for this: the institution that has the power to create money cannot, by definition, have a dire lack of money. Even with negative equity, a central bank can still be fully functional.

A more precise criticism is that central bank debt cancellation is a zero-sum game. For example, the chief economist of the French Treasury, Agnès Benassy-Queré, said that the gains from debt relief would be offset by a reduction in the central bank's profit distributions resulting from the losses on the Eurosystem's balance sheet.

However, the short-term gains from debt relief would be far greater than the small profit distributions that central banks pass on to their governments annually. In the case of France, the government could write off € 500 billion in debt (held under both the Pandemic Emergency Purchase Program and the Public Sector Purchase Program) while the annual profit distributed by the Banque de France is around € 6 billion for 2019.

The key is to remember that central banks are not like private companies. Your bookkeeping and balance sheets are defined purely by convention and should in no way be viewed as absolute legal or economic constraints. For this reason, instead of a complete cancellation, we could, for example, convert the government bonds into perpetual zero-coupon bonds in order to save the ECB's accounting department having to deal with losses.

We therefore fully agree that cancellation of the debt incurred through the bond purchase programs is technically feasible. But while the ECB's accounting rules are perhaps more flexible than one might think, the ECB still operates under fairly strict restrictions of EU law.

Legally impossible, politically complicated

We therefore disagree with the view that it would be legal for the ECB to unilaterally decide to cancel government debt. It is true that Article 123 of the Treaty on the Functioning of the European Union (TFEU), when it refers to the prohibition of monetary public financing, does not specifically provide for the case of public debt cancellation. Nevertheless, it is clear that the very intent of the proposal runs counter to the spirit of the EU Treaty. If anything, there is case law (see Accorinti and Nausicaa) in which the EU Court of Justice backed the ECB's decision not to participate in the 2012 Greek debt rescheduling program (albeit for the wrong reasons).

Of course, those in favor of debt relief are right to argue that the prohibition of monetary financing has become an obsolete rule in the face of non-emerging inflation. Unfortunately, in court decisions, the economic arguments rarely coincide with the legal ones.

Changing this situation, i.e. getting all EU states to agree to a treaty change in order to make debt write-offs legal, requires an extremely high amount of political capital. If one is optimistic, then instead of a treaty change, an implicit agreement on the reinterpretation or restriction of EU rules between EU heads of state and with the consent of the ECB would be sufficient. But this also seems unrealistic at the moment. Therefore, the question arises whether the benefits of debt relief would be worth the effort of making it legally possible. Unfortunately we don't believe that.

Not so obvious economic benefits

Proponents say that if we do not cancel the debt, at the end of the crisis, policymakers will impose austerity measures across the eurozone to repay the huge debts created by the Covid-19 pandemic. In order to kill two birds with one stone, they want the member states to commit to invest the equivalent of the debt relief for the transformation towards a climate-neutral economy.

But today, European governments - even Greece - borrow money at negative interest rates. That means investors are willing to lose a little money to hold government debt (instead of losing even more money if they parked their reserves with the ECB deposit facility). Indeed, while the national debt has increased significantly, the cost of servicing that debt has decreased.

Government debt as% of GDP


Government bond debt service due in two years as a percentage of GDP

Source: ECB Statistical Data Warehouse. Note: government bonds with 1 to 2 years maturity, debt service without capital,

In this context, debt relief may represent an unexpected rain of money for the tax authorities, but portraying it as an absolutely necessary precondition for more investment in climate protection clarifies the situation. Indeed, there is an unprecedented consensus among economists that public debt is a non-existent problem today.

This is also the reason why prominent scholars have proposed revising important fiscal indicators. For example, instead of using the misleading debt-to-GDP indicators, one could look at the debt ratioservice and look at GDP. By analyzing the dynamics between flows (debt service and GDP) instead of a mix of stocks (debt) and flows (GDP), the debt sustainability of governments would be better demonstrated.

In this context, a debt relief plan would bring additional profits, but these would not come as automatically and would not be as significant as one might think at first glance. There are also some risks that the proposal will not work as expected.

Indeed, as the OFCE researchers point out, depending on how debt relief is organized and communicated, all kinds of irrational behaviors could jeopardize the plan. The fear and lack of confidence of private investors that they might be next in line after central bank debt relief is over is just one example. Similarly, (irrational) fears of inflation could lead investors to demand higher returns. In this case, the immediate decrease in debt would be offset by an increase in the cost of borrowing to reissue debt.

Proponents of the ECB's debt cancellation are aware of this reality, but fear that the favorable borrowing conditions will not last forever. If central banks start raising interest rates, it would bring austerity back in full swing. While you are right to point out this potential risk, it would still be a missed opportunity not to take advantage of current negative interest rates to invest in long-term investments. Doing so now would, in fact, increase the chances of success in putting our economy on a sustainable growth path, which could indeed make debt relief unnecessary.

A better strategy

Positive Money Europe certainly wants to be at the forefront of new radical ideas, especially on how the ECB can better use its money-creating power to support society's interests. We share the same goal as those in favor of debt relief: we must ensure that Europe does not fall back into the self-destructive austerity ideology that almost killed the euro area in 2010.

The debt relief campaign has made a positive contribution to raising public awareness of the powerful role the ECB can play in this endeavor. But much more work is needed to change the public perception of public debt - starting with revising fiscal rules and debunking the belief that governments are like households (- they are not).

For a campaign organization like Positive Money Europe, it is crucial that we always find the best way to achieve concrete change while making the best possible use of the limited resources we have.

The central question is: if progressive forces today had the bargaining power to revise the EU treaty, should debt relief be our first priority?

Our conclusion is clear. Instead of a one-off debt cancellation, we would rather fight for permanent, long-term changes, such as a complete revision of the ECB statutes, including a revision of the ban on monetary financing and a complete overhaul of the EU's fiscal rules. A debt relief from the ECB would be the icing on the cake.

We don't shy away from proposals that require a treaty change. As we have said in the past, we believe that a treaty change will inevitably be on the table in the years to come and the Positive Money Europe team is working hard to build a powerful movement capable of making such a change bring about in the long term. However, all our hopes cannot rest on this distant and hypothetical possibility.

All in all, the proposal to cancel the debt held by the central banks makes sense from a technical point of view and should certainly be discussed further. Should Europe fail to achieve a strong and fair recovery after the Covid crisis, the proposal would certainly be a useful political option as a “last resort”. But our strategic analysis shows that the effort required to do this would be very high, while the potential gains are uncertain and smaller than one might initially think. Because of this, debt relief may not be our “first” priority for now.

There are other, more effective ways to implement progressive macroeconomic policies in the euro area. Therefore, Positive Money Europe's efforts are currently focused on key issues such as aligning the ECB's monetary policy with the EU's climate targets and creating political support for “helicopter money”. For next year we hope to be able to start new campaigns to combat over-indebtedness of small and medium-sized businesses and households, and to increase the momentum for a progressive fiscal framework. If we stay focused and let our movement grow, we have a real chance of realizing victories in the next few months.

🇬🇧English version of this article

🇫🇷 French version of this article

Italian version of this article